SENNINGERBERG, Luxembourg—Last year, David Arendt stood in a
reinforced concrete warehouse at Luxembourg’s airport and welcomed
wealthy collectors to his “fortress of art,” complete with high
security, minimal taxes and discretion. Mr. Arendt warned that it would
fill up quickly.

The 237,000-square-foot building, known as Le
Freeport, opened its 10-ton doors, joining a global network of
impenetrable warehouses where taxes are suspended and art can be stored
and sold away from prying eyes.

As the international art market
has boomed, so has demand for such discreet storage, particularly for
costly art picked up as an investment and never intended for a living
room wall. But a year after Luxembourg’s Le Freeport opened at a cost of
nearly $60 million, the Monets and Picassos have been slow to arrive.

The reason: the protracted public-relations disaster of Le Freeport’s biggest investor, Swiss entrepreneur Yves Bouvier. Mr. Bouvier was briefly jailed in Monaco earlier this year, after he was accused of selling paintings to Russian billionaire Dmitry Rybolovlev at inflated prices.
On Sept. 14, Mr. Bouvier faced new charges. He was questioned in France by authorities investigating allegations by Catherine Hutin-Blay,
the stepdaughter of Pablo Picasso, that works in her collection were
pilfered and sold to Mr. Rybolovlev. Mr. Bouvier was freed after posting
a €27 million ($30.5 million) bond.

In a statement, Mr. Bouvier denied the allegations in France and said
the pieces in question were properly purchased on behalf of his Russian
client. Some were meant for the walls of a chalet owned by Mr.
Rybolovlev, while others, including the Picasso painting “Espagnole à
l’éventail,” were deposited in a freeport in Geneva, he said. In an
interview with The Wall Street Journal in Geneva earlier this year, Mr.
Bouvier also denied the allegations of defrauding Mr. Rybolovlev.

Mr.
Rybolovlev’s attorney said authorities were free to examine works in
his collection believed to have been stolen. Mr. Rybolovlev hasn’t been
accused of wrongdoing.

The legal issues have amplified the
challenges facing Luxembourg’s Le Freeport, which was already contending
with a chorus of critics who say the opaque nature of freeports makes
them susceptible to illicit activity such as money laundering or
harboring stolen goods. Earlier this year, lawmakers in Luxembourg
responded to those concerns by bolstering the country’s
anti-money-laundering laws to specifically apply to firms operating at
Le Freeport—which now have a heightened legal responsibility to know
what they are putting into storage and for whom.

Mr. Arendt, Le
Freeport’s managing director, said the facility has safeguards to
prevent illegal behavior and that he is confident Le Freeport isn’t used
for money laundering. He also said the facility can adapt to the legal
change—and perhaps even use it as a selling point for “honest art
collectors.”

But Mr. Bouvier’s travails have hurt business.
“We’re behind on our objectives, as a result of all of this mess,” Mr.
Arendt said in an interview in May, as he sat in an empty showroom at Le
Freeport. On Wednesday, Mr. Arendt sounded hopeful that the bad
publicity had faded. “We’re more or less on track,” he said, though
“we’ve had a lot of explaining to do.” Mr. Arendt said Mr. Bouvier has
no role in running the freeport.

In the art market, “reputation is pretty much all you have,” said Harco van den Oever, who runs London-based Overstone Art Services.

About
60% of Le Freeport’s storage space has been rented to the firms that
deal directly with collectors and store their art at the building,
according to Mr. Arendt. The biggest of those firms, FineArt Logistics
Natural Le Coultre SA, which accounts for roughly half of that rented
space, is Mr. Bouvier’s company, and has so far only filled about 15% of
its available square footage.

Freeports are an outgrowth of
bonded warehouses, where commodities like grain in transit across
borders could be stored, without incurring taxes. There are dozens of
such warehouses around the world.

A few, like Le Freeport, are tailored to the needs of high-end art
collectors. At Le Freeport in Luxembourg, artwork that remains inside
its walls is exempt from value-added tax, which can be as high as 27% in
Europe, and from customs duty. Art sales within the building are also
tax-free. Art can remain in a freeport for years, through multiple
transfers of ownership. Firms offering art-related services like
restoration and financing set up shop on the grounds.

The value
of the global art market reached a record €51 billion last year,
according to a recent report published by the European Fine Art
Foundation, the organizer of a major annual European art fair.

Nearly
a third of art collectors and professionals surveyed last year by
Deloitte Touche Tohmatsu Ltd. said they had used a freeport. Experts
speculate that the freeport in Geneva, which traces its roots back to
1854 and is controlled by local authorities, may house the most valuable
art collection in the world—although its holdings are generally secret.

Proponents say freeports allow art to be moved around the world without
incurring punitive taxes. Critics say the warehouses can invite fraud.
“I can’t see any better way for people to launder money than to go
through a freeport,” says James Palmer, founder of Mondex Corp., which
specializes in recovering art looted from its rightful owners....MORE